Rosneft privatisation is a coup for the Kremlin, less so for Sechin

Rosneft privatisation is a coup for the Kremlin, less so for Sechin
Igor Sechin, CEO Rosneft
By Ben Aris in Berlin December 8, 2016

Igor Sechin, CEO of state-owned oil giant Rosneft, scored a major coup for the Kremlin by selling a 19.5% stake in the company to Qatar’s sovereign fund and oil trader Glencore for a reported €10.5bn, a 5% discount to the current market price of the company’s shares. But the deal may also be a move by President Vladimir Putin to clip the wings of his erstwhile lieutenant.

Until December 7, Russia watchers were expecting Sechin to go through with a ridiculous scheme where Rosneft’s parent company, the state-owned holding Rosneftegaz, would lend Rosneft the money to buy the stake itself on the promise that Rosneft would sell the stake to private investors some time in the future.

The deal would have literally moved money from one state-owned pocket to another, but left the management with more voting shares at its command. The deal was certain to go through as Sechin also happens to be the chairman of Rosneftegaz, which only has a few dozen employees anyway.

The Qatar/Glencore deal is a real and significant coup for the government as it means real fresh money will flow into the state coffers just when it needs it. The investment is equivalent to, “the last eight quarters of net inward direct investment to Russia (and most of that was in the last quarter),” according to Alex Nice, an analyst with the EIU.

But even more important is that the money is worth RUB678bn, which is about a third of this projected budget deficit; Russia is expected to end the year with a 3.7% of GDP deficit, or somewhere between RUB2 trillion and RUB3 trillion that it is struggling to finance.

This money will take a lot of pressure off the finance ministry, which was due to draw down RUB1 trillion from the Reserve Fund this month to cover the end of year costs and leaving RUB1 trillion left in the fund that is bound to be used up early next year. With this deal money the Reserve Fund will last longer and creates more wiggle room for finding other sources of funds in the new year.

Secondly, the deal is important politically as it further erodes the sanctions placed on Russia by the US and EU following the annexation of Crimea in 2014.

Rosneft is on the sanctions list but the structure used by Glencore manages to dodge these neatly and Qatar is a sovereign state and can do what it likes. More interestingly a “major European bank” is providing the financing, reportedly Italy’s Intesa Sanpaolo, which is more problematic as if it has financed the deal then it appears to violate the sanctions.

Streetwise digging

Dig into the details and this deal actually appears to be a lot more complicated than first appears. A widely circulated blog by the Streetwise Professor (actually Craig Pirrong, a real professor of finance and energy markets at the University of Houston) dated December 7 sums up many of the difficult questions the deal raises.

“Today saw a major surprise. I mean a major surprise. The Russian government announced that a consortium consisting of Glencore and the Qatar Investment Authority had purchased a 19.5% stake in Rosneft for €10.5bn. (Glencore said the price was €10.2bn.) The major surprise was that outside investors were involved at all at this time,” writes Pirrong.

While Qatar’s name had been in the ring for a while, Glencore’s appearance in the deal came out of left field; Glencore has always been close to Rosneft, which is a major source of oil for the trading company, but in recent years it has been selling off assets in an effort to stay alive after it over extended itself.

And the deal cut by Glencore’s owner Ivan Glasenberg was an extremely good one as the company only has to put up $300mn from its own resources to get control of a stake worth billions. Moreover, Glencore gets a supply contract for 220,000 barrels of oil a day to trade that makes it the largest oil trader in the world again. And a European bank that seems to be defying sanctions to finance the whole thing.

In fact this deal is too good to be true.

“But it appears there is some financial engineering going on here. A Glencore-QIA joint venture will buy the Rosneft shares, and the two investors will put up a mere €300 million each in equity. The remainder will be financed (according to Putin) by one of ‘the largest European banks’. Furthermore, the debt is supposedly non-recourse to Glencore or QIA. This means that the loan is essentially secured by the Rosneft shares,” the blog continues. “This would allow Glencore to keep the debt off its balance sheet, and skirt sanctions by not having an equity stake in Rosneft.”

If these numbers are correct then the leverage on the loan is 17.5-to-1, a level more typical of Alan Greenspan’s years of “excessive exuberance”.

Moreover, if Intesa Sanpaolo has financed the deal, and financed it on its own – as appears to be the case – then this loan would represent 20% of its entire equity. “That’s insane,” adds the Professor, pointing out the bank is in effect taking on a massive amount of risk with such a big loan to such a political hot potato.

It appears very likely there is a lot more to this deal that has not been disclosed. “So I am guessing that there is some other part of the deal that passes the equity price risk back to Glencore and QIA. For instance, a total return swap between the JV and its owners. Or a put (which would make it unnecessary for the JV to make payments to the investors in the event Rosneft stock rises in value, as would be the case in a TRS.) If that, or something like it, is going on here, this is a cute way to keep investment off Glencore’s balance sheet, and also may be a way to work around sanctions, because derivatives on Rosneft debt (e.g., CDS) and equity are not subject to the sanctions,” Pirrong writes.

“I cannot believe that any bank would lend so heavily based only on the security of Rosneft stock. So there must be a part of the deal that hasn’t been disclosed yet. (This may also involve an arrangement between Qatar and Glencore that limits the latter’s exposure.) There is more here than meets the eye, at least from the initial reporting,” the blog concludes.

One obvious way of mitigating some of these risks is if the Qatari sovereign wealth fund has other underlying deals to provide credit support to the Italian bank at least.

While the deal involves a huge amount of money, the amount and the machinations that are apparent from even a cursory look at the details of the deal all underline that actually this was a very poor deal for Russia and the consequences of Putin’s aggressive policies of the last two years.

The €10.5bn ($11.1bn) valuation on the 19.5% stake implies a market value of some $55bn for the company that is actually well below the valuation equivalents of Rosneft’s international rivals. Rosneft has 34.5bn barrels of oil equivalent (BOE) as reserves and produces some 1.75bn BOE a year, says the Professor. For comparison the reserves of ExxonMobil are a third of those of Rosneft and its output of 1.43bn BOE is 80% of Rosneft’s, but the company’s valuation is $350bn, or just over six-times higher and on a dollars per unit of reserves or output basis it is 8-9 times more valuable, he adds.

Finally, the deal is a boon for Russia and also Putin, but is it a boon for Sechin? The all-powerful boss of Rosneft has been doing everything to scupper the state’s efforts to either sell this stake, force him to pay the state-owned enterprises (SOE) mandatory 50% of profits as dividends (Rosneft has a special deal where it only has to pay 35%), and he even ignored a direct order by the Russian Prime Minister Dmitry Medvedev to disclose his salary publicly.

Clearly Sechin wants to retain personal and complete control over Rosneft and he has just been slapped down by having real foreign investors forced on him. Early this year the embattled Russian media outlet RBC reported on leaked documents that showed Sechin trying to force into the privatisation terms a ban on anyone signing a shareholders agreement with BP that already owns 19.5% of the company. Between them foreigners now own 39% of the company with another 5% floating freely on the markets.

Perhaps Putin finally thought that Sechin was getting too big for his boots and decided to trim his wings a little.